Here's 4 Ways The U.S. Election Could Affect The Dollar

Includes: UDN, UUP
by: Kathy Lien

The U.S. Presidential Election is finally here and it is one of the tightest races in recent memory. U.S. voters will go to the polls today and if we are lucky, by Tuesday evening we will know whether President Obama has been elected for a second term or if Mitt Romney will become the 45th President of the United States.

On Election Day in 2008, risk appetite was strong with gains seen in the EUR/USD, USD/JPY and stocks. However on the day that followed, the EUR/USD flatlined while USD/JPY and the S&P 500 fell sharply lower.

The price action of currencies and equities on the day after the election did not reflect the people's disappointment with the results - quite the contrary, America just made history by voting in its first ever African American President. Instead, the weakness in USD/JPY and the S&P 500, which began the day after the election and continued for 2 weeks to follow reflected the market's concern about the impact of Democratic policies. Republicans are generally considered more business friendly than Democrats and while there have been a number of reports that claim Democrats are more positive than Republicans for stocks, investors will still react impulsively.

Here are Four Ways that the U.S. Election could Impact the Dollar:

1. General Economic Policies - We already touched on general economic policies. Democrats tend to be less business friendly and President Obama specifically aims to close the budget gap by increasing taxes on multinational corporations that ship jobs overseas, the oil and gas industry, high income individuals, capital gains and dividends. Romney, on the other hand, is calling for broad based tax cuts. Which plan will effectively turn the economy and deficit around is a completely different discussion, but the mere prospect of Obama's policies hurting business could be enough to drive a reaction similar to 2008 where stocks and USD/JPY fell.

2. Handling of the Fiscal Cliff - While the winner's economic policies will have a significant impact on the handling of the fiscal cliff, the issue that we want to address is which winner will be more effective in getting Congress to agree on a solution. Since the Republicans have been blocking President Obama's plans to deal with the fiscal cliff, Mitt Romney may have an easier time breaking the political gridlock, which would be positive for the dollar.

3. Federal Reserve - If President Obama is reelected, he will most likely keep Ben Bernanke as the head of the Federal Reserve. Romney on the other hand has pledged to replace Ben Bernanke as Fed Chairman, which could cause significant volatility in the financial markets. The potential uncertainty would be significantly negative for the financial markets and deal a major blow to currencies and equities. Also Romney's choice of replacement would most likely be someone who is less dovish than Bernanke, which could be positive for the dollar.

4. China Policy - President Obama's administration has taken a subtler, behind closed doors approach to getting China to appreciate its currency. Mitt Romney has made it known that he would brand China a currency manipulator shortly after taking office. Doing so, could set off a trade war that may prompt China to threaten to dump its massive holding of U.S. dollars and U.S. Treasuries, which could pose a major risk to the U.S. recovery.

Overall, President Obama's policies are more negative for the dollar than Mitt Romney's even if they prove to be more effective in bolstering the U.S. economy in the long term. InTrade gives President Obama a 67% chance of winning the election but his victory is far from certain.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.